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Chapter 2

Issues raised with ASIC

2.1        The committee discussed a number of issues with ASIC at its oversight hearing on 17 June 2009. These included:

• short selling;

• market integrity;

• recent corporate collapses;

• BrisConnections;

• mortgage fund and cash management trust redemptions;

• PI insurance;

• ASIC's structure and budget; and

• investor education.

Short selling

2.2        As described in the committee's previous oversight report (tabled in February 2009), during the latter part of 2008 and early 2009 ASIC on a number of occasions extended the ban on covered short sales of financial stocks, indicating that it was concerned about short selling coupled with false rumours undermining the integrity of the market.[1] The ban on covered short sales of other stocks was lifted on 19 December 2008, while naked short sales have been banned entirely on a permanent basis following the passage through Parliament of the Corporations Amendment (Short Selling) Bill in December 2008.

2.3        The ban on short selling of financial stocks continued until 25 May 2009. Having first been implemented in September 2008, the length of the ban exceeded that of similar measures in overseas jurisdictions that moved to stop short selling during the period of heightened market volatility associated with the global financial crisis.

2.4        In response to queries about its timing, ASIC told the committee that by mid May 2009 it had formed the view that the systemic issues had eased sufficiently to re-open covered short selling of financial stocks. ASIC also stated that it had been correct in maintaining the ban for as long as it did:

...there is a trade-off between the systemic issues and confidence and leaving the ban on too long because it can affect price discovery and liquidity on the market, so we are very conscious of that. We felt that erring on the side of keeping the ban on for the systemic and confidence issues outweighed the benefits of price discovery and liquidity that would come from short selling. We monitored that and clearly we were very concerned. It was difficult to figure out how much of the volatility and what was going on in the market was due to the ban or the lifting of the ban. We felt that, on balance, a cautious approach, as we said in our media releases, was warranted for the Australian markets.[2]

2.5        The committee was also told that ASIC had kept its options open on short selling:

[Lifting the ban] has been working well in relation to covered short selling, particularly the gross disclosure. But, as we have said, if we believe that there are systemic issues or other issues that would concern us, we will not hesitate to reinstate the ban under the powers that we have and that have been confirmed in the more recent legislation.[3]

2.6        ASIC told the committee that the ban could be re-introduced if market conditions necessitated it:

...where you get a significant attack on financial stocks in an environment where there is not the confidence of people to go into the market and buy long—in other words, you do not have normal market behaviour—the long buyers stay out of the market and you are really just leaving it for the short sellers to continually sell. There would have to be fairly extreme circumstances. The best guide that I could give is probably back to September or October last year.[4]

2.7        ASIC also emphasised that short selling was still a matter of concern for regulators internationally, stating that 'there is still concern about short selling and how it operates'.[5]

2.8        Currently, covered short sales must be reported to the regulator under arrangements implemented when the ban on short sales of non-financial stocks was lifted. Clients are required to advise brokers of short sales, and brokers are required to report to the ASX the daily gross of short sales at the conclusion of each trading day.

2.9        The Corporations Amendment (Short Selling) Bill legislated for a disclosure regime for covered short selling that will broadly reflect ASIC's existing arrangements, with the details to be set out in regulations developed following consultation with industry. These regulations have not yet been put in place. The committee notes that the time interval between the disclosure of the short sale to the regulator and the release of that information to the market has been a matter of contention. 

2.10      ASIC was not able to tell the committee why the regulations had not yet been introduced, indicating that it is a matter for government. However, ASIC stated that the market has operated well with the existing gross disclosure arrangements.[6]

Committee comment

2.11      The committee welcomes ASIC's decision to lift the ban on covered short sales of financial stocks. As stated in its previous oversight report, the committee considers that covered short selling contributes to market liquidity and price discovery and is a valid feature of the Australian market.

2.12      The committee intends to continue monitoring the performance and effect of reporting arrangements for covered short sales, particularly when the arrangements to be determined by regulation replace the existing interim arrangements. The committee considers that transparency needs to be a key feature of these arrangements, in order to maximise information available to the market and to assist the regulator in identifying false market rumours without the need to resort to future bans.

Market integrity

2.13      Central to the recent short selling ban was concern over traders spreading false and misleading rumours. ASIC is responsible for identifying and prosecuting instances of such behaviour.

2.14      ASIC told the committee that its efforts to improve market integrity included:

• expanding enforcement teams;

• working closely with the ASX on rumours and non-disclosure;

• checking market activity and related rumours through ASIC's Market Watch team;

• receiving complaints and providing a website for people to anonymously report false rumours; and

• working with brokers to ensure they manage rumours appropriately.[7]

2.15      The committee questioned ASIC about the effectiveness of Project Mint, established to investigate instances of rumourtrage—that is, the practice of spreading false or misleading rumours to profit from trades.

2.16      ASIC told the committee that, as a result of Project Mint so far, it has banned one broker from trading and achieved one successful insider trading prosecution.[8] ASIC also told the committee that there had been no successful Project Mint-related prosecutions for spreading false and misleading rumours under section 1041E of the Corporations Act.[9] However, ASIC has commenced one prosecution under s1041E since it came into force.[10]

2.17      Despite the lack of prosecutions it has led to so far, ASIC told the committee that Project Mint was a work in progress and that it had already had an important deterrent effect.[11] There was some debate over whether improved market behaviour was a result of ASIC's investigations or a consequence of recent market conditions. ASIC officials told the committee that their experience in working with brokers indicated that their enforcement efforts had been effective in changing behaviour.[12]

Committee comment

2.18      The committee recognises that it can be difficult to effectively measure the deterrence effects of a program such as Project Mint. In the absence of such measures, however, it is also difficult to judge whether the resources allocated to the project are justified.[13] If the project is to continue in its current form, the committee expects that ASIC will be in a position to report further related bannings and prosecutions at future oversight hearings.

2.19      The committee notes that ASIC expressed a view that enhanced electronic surveillance powers would enhance its ability to successfully investigate insider trading matters.[14] The committee also notes that, since its oversight hearing took place, the Australian Government has announced that ASIC will assume responsibility for all supervision and surveillance of financial markets and market participants (a role currently performed by the ASX) from the third quarter of 2010. The process of putting in place a legislative framework for ASIC to take on this role may provide an opportunity for government to consider extending ASIC's electronic surveillance powers.

Corporate collapses

2.20      In recent times and during the last 12 months in particular, substantial and ongoing volatility in the markets has been accompanied by a number of high-profile corporate collapses in Australia. ASIC described the extent of the resulting losses to the committee:

...to date major company insolvencies such as those of ABC, Allco, Babcock and Brown, Great Southern, Octaviar and Timbercorp have resulted in a loss of value of around $23 billion, calculated from the peak market capitalisation of each of those entities. A further 11 entities have lost more than 90 per cent of their market capitalisation; the aggregate loss there is another $39 billion. They include the listed funds in Allco and Babcock and Brown. Twenty-three debenture issues have become insolvent, with a total of $3.1 billion of debentures on issue, including $1.8 billion in the unlisted, unrated debenture area, which is an area of particular concern for retail investors. So the total of those is around $73 billion. As the downturn in the real economy continues, the figure may well increase. Clearly the real estate sector remains a concern, particularly in relation to REITs and unlisted mortgage and property trusts. To put these collapses into perspective, losses from corporate collapses in the wake of the 1987 stock market crash were around $20 billion, which equalled about 5.4 per cent of the 1989 GDP. The figure of $73 billion which I have just mentioned is about 6.2 per cent of the 2008 GDP.[15]

2.21      The committee questioned ASIC about several key collapses.

Storm Financial

2.22      The collapse of Storm Financial, headquartered in Townsville but with clients spread across Australia, is of such concern to the committee that it is a focus of its current inquiry into financial products and services.[16]

2.23      At the 17 June 2009 oversight hearing, ASIC updated the committee on the progress of its ongoing investigations into Storm. It indicated that these may lead to efforts to obtain compensation for affected investors:

These investigations extend to possible action to recover compensation under section 50 of the ASIC Act against all involved, including financiers. We have set an internal objective for us to hopefully be able to make decisions on those matters by the end of August, but it is very much an internal objective.[17]

2.24      Also on 17 June 2009, the Commonwealth Bank of Australia (CBA) announced a moratorium on the repayment obligations of Storm clients until 31 August.[18] ASIC supported this decision, stating that it would relieve Storm clients of the pressure of having to make informed decisions about settlement deeds while subject to immediate debt repayment obligations.[19]

2.25      Since the oversight hearing, the CBA has extended the interest payment moratorium for Storm clients through until 30 September.[20]

Committee comment

2.26      The committee has received more than 400 written submissions to its inquiry into financial products and services, and the majority of these submissions relate to the collapse of Storm Financial. The committee intends to reserve comment on this matter until it completes this inquiry and tables its final report on 23 November 2009.

2.27      The committee has taken evidence about Storm's collapse at seven public hearings to date and intends to hold further hearings. This will include taking updated evidence from ASIC regarding the progress of its investigations. In particular, the committee will welcome any announcement ASIC is able to make regarding its intention to take action against parties involved in the collapse.

Agribusiness managed investment schemes (MIS)

2.28      The recent collapses of agribusiness managed investment schemes (MIS) Timbercorp and Great Southern prompted the committee to announce an inquiry into aspects of agribusiness MIS.[21]

2.29      At the 17 June oversight hearing, ASIC outlined the situation facing investors in Timbercorp and Great Southern:

... both Timbercorp's and Great Southern's core business was to structure and operate tax-deferred forestry and horticultural schemes. Timbercorp had approximately 18,400 investors, having raised around $1.095 billion. Great Southern had approximately 43,000 investors and raised about $1.8 billion. Both these scheme operators are now in voluntary administration. The effect of these collapses for investors is dependent upon the position of the scheme in which they have invested. Each has a number of schemes. In relation to Timbercorp, for example, the administrators have provided an initial view and have applied to the court to seek some directions as to whether they should wind up 21 horticultural schemes that they run. ASIC is involved in these proceedings and will seek to ensure that the administrators are acting in the best interests of members. In relation to Great Southern, at this stage neither the administrators nor the receivers have had sufficient time to assess the position of the schemes. ASIC is looking at a range of regulatory issues around these collapses—issues such as the misuse of fees, whether there has been adequate disclosure, and governance.[22]

2.30      ASIC also indicated to the committee that a key issue in responding to such collapses was exercising a judgment as to whether it may need to intervene to replace the responsible entity (RE)—that is, the scheme operator—in order to better protect the interests of creditors:

As part of monitoring these schemes the difficult question for ASIC is whether to intervene and replace an RE or whether to allow it to continue. ASIC’s approach is to assess each case on its merits. It is alive to the issue of potential conflicts of interest that an RE may be involved in, between the interests of creditors and the interests of members and its obligations to have the interests of members as the priority.[23]

Committee comment

2.31      The committee tabled its report on aspects of agribusiness MIS on 7 September 2009. In that report it makes two recommendations relevant to ASIC:

• that the government amend the Corporations Act to require ASIC to appoint a temporary Responsible Entity when a registered managed investment scheme becomes externally administered or a liquidator is appointed; and

• that ASIC require agribusiness MIS to disclose the qualifications and accreditation of third parties that provide expert opinion on likely scheme performance.[24]

2.32      The committee has now completed its formal inquiry into aspects of agribusiness MIS, and it is for the government to respond to the recommendations put forward. However, the committee remains concerned about outcomes for Timbercorp and Great Southern investors and requests that ASIC updates the committee at the next oversight hearing on its investigations into the regulatory aspects of these collapses.

BrisConnections

2.33      Committee members questioned ASIC about BrisConnections, which has a 45-year concession to design, construct, operate, maintain and finance the Airport Link toll road in Brisbane. A substantial number of retail investors apparently bought partly paid shares in BrisConnections at a very low price, without realising that these shares carried a liability for two further payments.

2.34      ASIC told the committee that it had already acted to ensure that future investors in partly paid shares are explicitly made aware of what they are buying:

We understand that a lot of people bought shares on the internet and claimed that they were uninformed of the fact that the shares were partly paid. Since then the ASX has required that as from 1 May investors have to sign an acknowledgment that they understand they are buying partly paid shares. That rule change was implemented. Even before that, in March, there was a stopping of straight-through processing and brokers were going back to ask investors if they knew what they were doing.[25]

2.35      The committee asked ASIC whether it was doing further work in relation to governance issues surrounding BrisConnections, including:

• the actions of investor Nicholas Bolton, who bought sufficient shares to call a meeting of investors; and

• claims about potentially misleading revenue projections by BrisConnections, based on ambitious assumptions about likely traffic flows, used by BrisConnections in its disclosure material.

2.36      ASIC indicated that it had a taskforce examining these matters but preferred not to comment further because of the ongoing nature of its investigations.[26]

Committee comment

2.37      The committee welcomes ASIC's move to ensure that the ASX obtains a signed acknowledgment from investors in partly paid shares. This will help future investors to avoid the situation that some BrisConnections shareholders found themselves in of being unable to cover the liabilities on the shares they had purchased.

2.38      The committee remains deeply concerned about some of the other governance and disclosure issues allegedly surrounding BrisConnections and urges ASIC to take any relevant action in a timely fashion. The committee expects an update on these investigations at the next oversight hearing.

Mortgage fund and cash management trust redemptions

2.39      As outlined in the committee's previous oversight report, following the 12 October 2008 announcement of an unlimited government guarantee for all deposits in Australian bank accounts, many (non-guaranteed) cash management trusts and mortgage funds imposed a freeze on redemptions to help maintain stability. On 31 October 2008 ASIC announced that it would provide regulatory relief to enable withdrawals from frozen funds on hardship grounds.[27]

2.40      At the 17 June 2009 oversight hearing, committee members asked ASIC about the rationale behind the freeze and the impact that it has had on those whose funds have been frozen. ASIC suggested that the bank deposit guarantee was not the sole cause of the freeze on redemptions:

...cause and effect is interesting. Yes, there was a bank guarantee and, yes, there was a freezing of redemptions, but freezing was going on before the guarantee as well so you need to look at market movement, at what was happening in the market.[28]

2.41      However, ASIC later acknowledged that the bank deposit guarantee accelerated the extent to which funds were shifted out of mortgage funds and into guaranteed accounts.[29]

2.42      When questioned about the likely timetable for the lifting of freezes, ASIC suggested that getting the necessary new funds to flow into these investment vehicles for redemptions to recommence 'is probably going to be a slow process'.[30] ASIC stated that 'it is a market driven issue', with gradual unfreezing likely to occur as the market improves.[31]

2.43      The clear difficulty in this scenario is that funds will not attract new funds while they are frozen, yet without new funds it is difficult to unfreeze given the likelihood of at least some level of redemptions. ASIC indicated that it was trying to find solutions to this problem:

One of the things we have done is initiated discussions with IFSA to see what we can do to try to come up with some innovative solutions to try to unfreeze the funds. Clearly, as the chairman was saying, with the state of the markets at the moment—the property market—selling assets is not necessarily a good solution. But there are other things that we think could be looked at in terms of trying to unblock.[32]

2.44      ASIC suggested that one possible solution could involve investors seeking to liquidate their funds accepting a discount:

If the assets have to be liquidated, they may want to take a discount—if that is what they want: liquidity. That is the issue about liquidity. I think that is the issue about these funds. There are also then people who want to take a long-term view and are willing to stay there and perhaps realise the assets at their full value over time. I think that is the sort of dilemma that we need to sit down and discuss with the industry—and see whether we can find a solution to try and unlock it for those who want to get liquidity while not disadvantaging those who are willing to stay there for [the] long run when markets perhaps stabilise and asset value can be released over time. I think that is really what has to be looked at as an industry.[33]

2.45      Committee members also asked ASIC officials for their assessment of the adequacy of the regulatory relief arrangements that had been put in place to enable withdrawals from frozen funds on hardship grounds. In response, ASIC acknowledged that the arrangements were somewhat arbitrary and agreed to provide statistics relating to hardship-related withdrawals on notice.[34] On the figures available to ASIC as of 18 August, around 0.2 per cent of funds under management had been paid out on hardship grounds, with average payments of around $25,000.[35]

Committee comment

2.46      The committee welcomes ASIC's announcement of 17 August 2009 that it has now expanded relief for hardship withdrawals from frozen funds. ASIC has lifted he cap on hardship withdrawals to $100,000 each calendar year, increased to four the number of hardship withdrawals that can be made each year, and extended the list of recognised hardship grounds.[36] These steps should assist individuals who were affected by the fund freezes to more readily access adequate funding.

Credit rating agencies

2.47      At the previous oversight hearing, ASIC indicated that it would be responsible for the application of new arrangements on how credit rating agencies (CRAs) operate. The reforms are to include removing the exemption from holding an Australian Financial Services Licence, and requiring rating agencies to issue an annual compliance report outlining rating processes and how any conflicts of interests are being managed.

2.48      At the 17 June 2009 oversight hearing, ASIC told the committee that it would now delay the introduction of these new rules from 1 July 2009 until 1 January 2010. The reason given is that extra consultation is required because of international developments, which may be more prescriptive than originally anticipated. ASIC advised that the delay had not affected its monitoring and surveillance of credit agencies.[37]  

2.49      With respect to the securitised debt products that the credit rating agencies failed to appropriately rate, ASIC indicated that it had produced a discussion paper as part of its work co-chairing a global task force on this subject. One of the recommendations contained in the paper explores the potential distinction between selling to sophisticated and unsophisticated investors:

 ...whether there should be an obligation on the part of sellers of financial instruments such as these to determine whether the party that is buying financial instruments really is suitable and has adequate education.[38]

2.50      ASIC added that the failure of the credit rating agencies reinforced that investors should not blindly rely on them and should do their own due diligence on investment products.[39]

Committee comment

2.51      The committee agrees with, and wishes to emphasise, ASIC's comment that ratings provided by agencies are no substitute for investor due diligence. As indicated in its previous oversight report, the committee welcomes measures designed to address deficiencies in the operation of CRAs—particularly measures designed to manage conflicts of interest—and looks forward to the 1 January 2010 introduction of new regulations on CRA operation in Australia.

PI insurance

2.52      ASIC officials informed the committee that the market for professional indemnity (PI) insurance is 'hardening'. They said that ASIC would continue to monitor the effect on smaller operators:

...the willingness to write cover and the price of that cover are certainly under pressure. We are keeping in very close touch with what is happening, because it is, after all, a market solution, and when the market is pressurised that solution becomes more difficult to render. Is it forcing small players out of the market? We do not think so. It is right on the edge at the moment. If the market materially hardened further then there might be some smaller licensees that are unable to get cover. That has always been a potential in this policy, and we have always made it quite clear that we would be realistic and would assess the particular circumstances of licensees as and when that happened.[40]

2.53      ASIC explained that a limitation of the scheme is that the policies are not standardised. Therefore, some policies may not apply in certain circumstances, such as fraud.[41] ASIC further noted that some advisers have been informed that their insurer will not cover advice on margin lending products.[42]

2.54      However, the committee was also informed of the positive effect the requirement for PI insurance was potentially having on risk management practices:

There is actually quite an interesting positive that has come out of it and that is that insurers are now looking a little bit more closely at what the risks actually are. There is now engagement: 'It seems as though that particular product has caused a lot of problems, and we do not think your systems are satisfactory. Therefore, we are not going to cover you for going forward in relation to that product.' There is not now more focus on exactly where these risks come from. The insurers have learnt more about the way financial products tend to have problems that go right across the board. That level of engagement about what is happening in the business of advisers is possibly quite a healthy thing.[43]

Committee comment

2.55      The committee is of the view that some consumers of financial products and financial advice have a false expectation of protection that may be afforded to them via PI insurance in the event of financial losses. The committee therefore encourages ASIC to make efforts to educate consumers about the true nature of PI insurance.

2.56      The committee notes that ASIC's two-year implementation period for the PI insurance scheme ends at 31 December 2009 and, after this time, Australian Financial Services licensees will be required to hold a higher standard of PI cover.[44] The committee is concerned that AFSL holders may find it difficult to meet this requirement in a 'hardening' insurance market and will seek an update from ASIC at its next oversight hearing regarding the true availability of PI insurance in the marketplace.

ASIC structure and budget

2.57      ASIC confirmed to the committee that Dr John Stuckey has been appointed as chair of ASIC's external advisory panel, which meets two or three times a year.[45] ASIC described the role of the panel as follows:

The advice is very informal. It is to promote discussion and get views on matters which we can then assess as commissioners and factor into the other advice and inputs that we get. So we do not formalise it and we do not attribute the comments.[46]

2.58      The committee discussed the adequacy of ASIC's budget given its proposed additional responsibilities for national regulation of consumer credit. ASIC told the committee that its resources are sufficient at present:

Our feeling at this point, going into next financial year, is that we are adequately resourced for what we need to do. The government has given us the additional resources in relation to credit and a number of other matters. As chairman, I feel confident that I can raise with government if we feel we do need additional resources. Whether we would get those or not is a matter to be discussed, but at this stage the commission feels that, in the foreseeable future, given what we have and what we think will happen, we do have adequate resources. As an agency, obviously resources are very important, but we are very keen to demonstrate—and I think we have been demonstrating—that when we ask for further resources we have got a genuine case. Our track record on credibility is very important to us.[47]

Committee comment

2.59      The committee notes that the government's decision to hand responsibility for market supervision to ASIC from the ASX will have a significant effect on ASIC's budgetary requirements. The committee will seek further information on this at its next oversight hearing.

Investor education

2.60      ASIC told the committee that its education initiatives are focused on relaying the need to understand the importance of asset diversification and pricing risk. ASIC said that its retail investor education and school-based financial literacy programs would make a difference, but that some people would inevitably take poor advice and make poor investment decisions.[48]  

2.61      ASIC noted that limiting investments available to retail investors might protect them from making poor decisions, but it might also limit the efficiency of the markets and increase the cost of investing, to the detriment of investors as a whole.  They indicated that the balance between market efficiency and investor protection is ultimately a matter for government.[49]

Committee comment

2.62      The committee acknowledges that investor education and financial literacy programs in schools will only go part of the way to protecting investors from making poor financial decisions. However, the committee considers that such programs are an essential part of increasing overall financial literacy in Australia and encourages ASIC to continue to prioritise this work.

2.63      There is a need to diversify the delivery of education programs. For example, any overemphasis on online education risks disenfranchising the more elderly members of the population, who are less likely to access internet-based information or training. The committee encourages ASIC to take such factors into account when designing and distributing educative material.

2.64      The committee also reiterates its position that ASIC should do all in its capability to promote its investor education messages through mainstream press coverage.

 

Mr Bernie Ripoll MP
Chairman

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